Evaluating 2x Leveraged ETFs vs. 3x Leveraged ETFs for Portfolio Management

So, you're thinking about diving into the wild world of leveraged ETFs ? Buckle up, because we're about to take a rollercoaster ride through the land of amplified returns and magnified risks.

Understanding Leveraged ETFs

Leveraged ETFs are like the adrenaline junkies of the investment world. They use derivatives and debt to pump up the returns of an underlying index. Think of them as the financial equivalent of a double shot of espresso. A 2x leveraged ETF aims to give you twice the daily return of the index, while a 3x leveraged ETF is like, "Hold my coffee," and goes for three times the daily return

Performance Comparison

·       2x Leveraged ETFs: Imagine if the S&P 500 goes up by 1% in a day. A 2x leveraged ETF like SSO would be like, "Let's make it 2%!" But if the S&P 500 takes a nosedive by 1%, SSO would be like, "Oh no, we're down 2%!" 

·       3x Leveraged ETFs: Now, if you're feeling extra adventurous, a 3x leveraged ETF like UPRO would triple that daily return. So, a 1% gain in the S&P 500 means a 3% gain for UPRO. But beware, a 1% drop means a 3% loss 3.

Cumulative Returns

One needs to understand that leveraged ETFs tweak their leverage every day, which can lead to something called "volatility decay." So, over time, the returns of these ETFs might end up way different from what you'd expect based on the index performance. This gets even more noticeable with higher leverage.

Risk Considerations

• Volatility Risk: These ETFs are designed to amplify daily returns, so if the market decides to go the other way, your losses get amplified too. It's like riding a rollercoaster blindfolded.
• Compounding Risk: Thanks to the daily reset mechanism, the effects of compounding can lead to some wild deviations from expected returns over time, especially during high volatility .
• Decay Risk: Higher leverage means greater decay over time. It's like watching your ice cream melt faster on a hot day. This decay can erode returns, making 3x leveraged ETFs riskier for long-term holding compared to 2x leveraged ETFs

 

What does the data say?

Let's talk numbers. If you started with an initial investment of $10K and added $1K at the end of each month, here's how things would look:

	Invested amt	Final Amt	CAGR	Volatility	Max Drawdown
S&P 500	$133,000.00	$277,296.73	12.06%	18.13%	-33.69%
SSO	$133,000.00	$376,285.12	17.23%	36.27%	-59.34%
UPRO	$133,000.00	$425,399.48	19.50%	54.32%	-76.82%

	S&P 500		SSO		UPRO
Year	Return	Balance	Return	Balance	Return	Balance
2025	-5.74%	$277,296.73	-15.16%	$376,285.12	-25.20%	$425,399.48
2024	25.00%	$291,168.84	43.47%	$440,491.30	63.55%	$565,621.31
2023	26.31%	$222,472.25	46.66%	$297,459.36	68.58%	$337,057.47
2022	-18.09%	$165,537.88	-38.98%	$193,005.37	-56.83%	$190,772.35
2021	28.87%	$188,136.67	60.57%	$299,120.76	98.64%	$420,069.84
2020	18.49%	$135,490.01	21.53%	$176,882.55	10.08%	$202,971.30
2019	31.35%	$102,317.61	63.45%	$132,037.00	102.31%	$167,534.14
2018	-4.47%	$67,736.95	-14.62%	$71,882.89	-25.15%	$74,985.56
2017	21.81%	$59,275.13	44.35%	$72,512.56	71.37%	$88,322.49
2016	12.11%	$37,840.97	21.55%	$40,316.36	30.78%	$42,437.11
2015	1.40%	$22,220.60	-1.06%	$21,828.27	-4.99%	$21,202.69

 

Tempting, isn’t it? But you do need the strength to endure a 76% drawdown

 

If instead of DCA, one only stuck with an initial investment of 10k, the annual returns will be as follows

	S&P 500		SSO		UPRO
Year	Return	Balance	Return	Balance	Return	Balance
2025	-5.74%	$32,341.23	-15.16%	$51,497.21	-25.20%	$62,769.83
2024	25.00%	$34,309.54	43.47%	$60,702.46	63.55%	$83,920.70
2023	26.31%	$27,446.95	46.66%	$42,309.30	68.58%	$51,311.67
2022	-18.09%	$21,730.21	-38.98%	$28,847.98	-56.83%	$30,437.17
2021	28.87%	$26,530.85	60.57%	$47,272.55	98.64%	$70,513.05
2020	18.49%	$20,587.96	21.53%	$29,440.68	10.08%	$35,498.18
2019	31.35%	$17,375.93	63.45%	$24,225.27	102.31%	$32,248.89
2018	-4.47%	$13,229.16	-14.62%	$14,820.82	-25.15%	$15,940.10
2017	21.81%	$13,847.76	44.35%	$17,358.79	71.37%	$21,295.40
2016	12.11%	$11,367.88	21.55%	$12,025.33	30.78%	$12,426.24
2015	1.40%	$10,140.19	-1.06%	$9,893.68	-4.99%	$9,501.28

 

Suitability for Portfolios

• Short-Term Trading: Both 2x and 3x leveraged ETFs can be effective tools for short-term traders looking to capitalize on market movements. If you're a thrill-seeker with a high-risk appetite, 3x leveraged ETFs might be your jam. But if you're a bit more conservative, 2x leveraged ETFs could be a better fit.

• Long-Term Investment: Leveraged ETFs are generally not recommended for long-term investments due to the risks of volatility decay and compounding effects. However, if you're determined to hold these products long-term, 2x leveraged ETFs might be a slightly safer option compared to 3x leveraged ETFs.

• Portfolio Diversification: Incorporating leveraged ETFs into a diversified portfolio requires careful consideration. These ETFs should complement other assets and align with your overall strategy. Risk management techniques, like setting stop-loss orders and regular portfolio rebalancing, are crucial when dealing with leveraged products.

Conclusion

Leveraged ETFs can be powerful tools, but they require careful management and an understanding of their complexities to avoid potential pitfalls. Do your homework, and consider consulting with a financial advisor to determine the most appropriate leveraged ETF for your portfolio.